Transactional class and derivative actions have long been controversial in both the popular and the academic literatures. Some commentators have argued that every deal faces litigation, that the overwhelming majority of such cases are frivolous, that the only people who benefit from them are the lawyers, and that the costs of these suits outweigh their benefits to shareholders. Others have taken the opposite view, that the litigation costs are overblown and that shareholders benefit from such suits. Yet, the debate over this litigation has so far neglected to consider a change in legal technology, adopted in Delaware a decade ago, favoring selection of institutional investors as lead plaintiffs. My article, “Private Policing of Mergers and Acquisitions: An Empirical Assessment of Institutional Lead Plaintiffs in Transactional Class and Derivative Actions,” fills the gap, offering new insights into the utility of mergers and acquisitions litigation. The most significant findings in the paper are that public pension funds and labor union funds have become the dominant institutional players in these cases, and that public pension fund lead plaintiffs correlate with the outcomes of most interest to shareholders: an increase from the offer to the final price, and lower attorneys’ fees.
Posts Tagged ‘Pension funds’
Recently issued rules by the Governmental Accounting Standards Board (GASB) will notably change the way state and local governments account for and report the results of their defined benefit pension plans. Some plans may see their reported funded percentages fall under the new requirements. A plan’s funded status will now be reflected on the balance sheet, increasing transparency as well as the focus on measures that plan sponsors are taking to address these shortfalls. Funded status and pension expense measures are also likely to be more volatile under the revised reporting standards.
While the new GASB rules change some important aspects of public DB plan reporting, they do not change others. In particular, they neither mandate use of a lower discount rate for calculating liabilities nor higher contribution requirements. These are changes to accounting and financial reporting, not economics. Nonetheless, they do represent a notable change to the calculation and reporting of various pension-related metrics.
Some public DB plan sponsors are already facing significant challenges, such as relatively low funded levels. In addition, given budgetary challenges, some state and local governments do not have the flexibility to increase contributions at this time. All of this is occurring in an environment where long-term expected returns across a wide variety of asset classes have been falling. The GASB changes may add yet another layer of stress, if not complexity, for some public plan sponsors.
This paper reviews the following aspects of the GASB changes:
For many employers, underfunded defined benefit pension plans present significant ongoing challenges. These challenges arise not only because of the underfunding itself, but also because of the significant volatility that the underfunding can create on its balance sheet due to changes in interest rates and other key assumptions over time. An employer has always had the ability to seek to improve its longer-term financial profile by “de-risking” its pension plan through the purchase of an annuity from a suitable annuity provider that commits to pay benefits to plan participants without further financial support from the employer. The transfer of pension obligations in this manner, which may include the termination or partial termination of the pension plan, can significantly improve an employer’s financial profile. De-risking transactions have become more prominent in recent months because of two transformative transactions, one involving General Motors and the other involving Verizon. We are pleased to report that the first judicial test of these transactions in court under ERISA, the Federal benefits statute, has resulted in a victory for the parties involved in the transaction. And, while the decision was based only on a request for preliminary injunctive relief, and while future litigation will be based on the manner in which future de-risking transactions are structured (including on the key issue of annuity provider selection and suitability), the decision validates the central thesis of pension de-risking and provides an important and helpful roadmap through some of the potential ERISA challenges to these transactions.
Private equity funds (PE funds) and their advisors long have been concerned that a fund (or its other portfolio companies) may be liable for unfunded pension plan liabilities of one of its portfolio companies. However, in a decision published last month, the U.S. District Court of Massachusetts held that three PE funds sponsored by Sun Capital were not liable for any portion of the withdrawal liability incurred by a portfolio company in which the funds collectively held a controlling interest. In reaching this decision, the court expressly rejected the analysis contained in a 2007 Pension Benefit Guaranty Corporation (PBGC) Appeals Board opinion, which found that the investment activities of a PE fund constitute a “trade or business” and thus subjected the PE funds to joint and several liability under Title IV of the Employee Retirement Income Security Act (ERISA) for a portfolio company’s unfunded pension liabilities.
Although the Sun Capital Partners case provides a foundation for cautious optimism on the issue of whether PE funds can be held jointly and severally liable for the pension-related liabilities incurred by portfolio companies in which they invest, it remains to be seen whether its analysis will be adopted by other courts and whether the district court’s decision will be upheld on appeal to the First Circuit. PE funds should continue to view control group liability as a potential risk in the acquisition context and, in order to minimize exposure to unfunded pension liabilities, PE funds should consult counsel when encountering these issues.
In our paper, Corporate Governance and Risk-Taking in Pension Plans: Evidence from Defined Benefit Asset Allocations, forthcoming in the Journal of Financial and Quantitative Analysis, we examine whether good corporate governance leads to a larger allocation of pension assets to risky securities as compared to safe investments. Defined benefit (DB) plans are one of the most important private retirement schemes in corporate America. Although pension regulations require firms to establish separate trusts to manage and invest DB pension plan assets, these pension plans are owned by the sponsoring corporations and the plan asset allocations are made under the influence of, if not the direction and control of, the plan sponsors. Depending on the firm and plan characteristics as well as the market environment, firms may have different incentives in investing pension assets, namely, either risk-taking by allocating a larger share of plan assets to risky asset classes (e.g., equity) or risk management by investing heavily in safe asset classes (e.g., cash, government debt, and guaranteed insurance contracts).
In the paper, The Pension System and the Rise of Shareholder Primacy, which was recently made publicly available on SSRN, I explore the influence of the pension system on corporate governance, particularly shareholder primacy and the relationship between corporations and their employees. Today it is widely accepted among business managers, scholars of corporate law and financial economists that the objective of corporate law and corporate governance should be to promote shareholders wealth (as opposed to a wider community of interests, including employees, creditors, suppliers, customers and local communities). Shareholder capitalism is, however, a relatively recent development. Large, publicly-traded corporations in the middle of the 20th century were characterized by managerial capitalism: managers had taken over the role of entrepreneurs within the firm, and compared to their predecessors they were hardly accountable to owners. Economists sometimes saw this as an advance over previous periods characterized by dominant founders, given that the system seemed more rational and stable. Around 1980, managerial capitalism began to give way to investor capitalism. Hostile takeovers, and later equity-based executive compensation, began to emerge as the new forces creating incentives for managers to focus on share value.
As an SEC Commissioner focused on investor protection, I’d like to talk to you today about some issues important to investors in the current capital market environment, and how public pension funds, in their capacity as shareowners and investors, can be a more effective voice for America’s working families.
Investors are the Capital Providers — The Economic Impact of Public Pension Funds
First, I want to quickly highlight the critical role public pension plans have in our economy. As they often do, the statistics tell the story: State and local pension plans serve about 14.4 million active employees, and pay benefits to about 7.5 million current beneficiaries. In 2010, public pensions paid an average benefit of just under $26,000 per year. That regular income provides security, stability and peace of mind that individual savings and defined contribution plans alone cannot ensure for most workers.
Pension plans may also help reduce the disparity in retirement incomes between men and women, as well as the wide income gulf between white and non-white households in retirement. A 2009 report by the National Institute on Retirement Security found that, while older households headed by women, and those headed by people of color, were significantly more likely to be classified as poor than their male and/or white counterparts, that disparity is substantially reduced among households receiving pension income.
In its annual Institutional Investment Report, which was released on November 11, The Conference Board provides a comprehensive analysis of the asset growth and portfolio composition of institutional investors operating in the United States. It documents the presence over 30 years of different types of institutional investors in single asset classes such as equity, debt securities, alternative instruments, and foreign securities, drawing on data from a wide range of sources. This year’s report includes definitive data for 2009 and focuses on the impact of the financial market rebound on institutional asset value and investment decisions.
Following 2008’s dramatic decline of the securities markets, by the end of 2009 the investment industry had registered substantial gains across virtually all classes of financial instruments, with total institutional assets rising 14 percent to $25,351.1 billion—a level similar to that recorded between 2005 and 2006. This constitutes an extraordinary upward movement from the 21.3 percent plunge of 2008, albeit still far from the best performances of an industry that between 1995 and 2007 had experienced unprecedented growth of 23.3 percent on an annualized basis. Of course, the historical significance of this finding should also be put in context with the new economic uncertainties and the added market volatility of the last few months.
The following are the other major findings discussed in the report.
Public pension funds have played a prominent role in securities class actions, comprising nearly half of all institutional investor lead plaintiffs. Overall, prior research has shown that the funds perform admirably in the lead plaintiff role, increasing recoveries for the class of defrauded shareholders, improving corporate governance, enhancing the independence of the board, and lowering attorneys’ fees. Recently, several articles in the business press and a concerted lobbying effort have argued that the funds’ participation in these class actions is driven by “pay-to-play”. In this context, “pay-to-play” means that politicians on pension fund boards direct the funds to obtain lead plaintiff appointments in exchange for campaign contributions from plaintiffs’ law firms. In my paper recently posted on SSRN, Is ‘Pay-to-Play’ Driving Public Pension Fund Activism in Securities Class Actions? An Empirical Study, I conclude that “pay-to-play” is, at most, a marginal factor in the funds’ participation in securities class actions.
In Modernizing Pension Fund Legal Standards for the Twenty-First Century, we explore the symbiotic relationship between sustainable success of the corporate sector and the ability of pension funds to successfully fulfill their mandate. We note that exponential growth in the size of pension fund assets since the 1970s and their current collective ownership of public corporations has turned pension fund governance into a major corporate governance factor. We argue that traditional views of pension fund governance and fiduciary responsibility, which developed during a time when pension fund investment practices had little effect on the markets, are outdated. With institutional investors owning 76 percent of the Fortune 1000, pension fund governance and corporate governance are now opposite sides of the same coin, with each exerting a major influence on long-term success of the other.
We concentrate on the pension fund side of this relationship and argue for a modernized interpretation of fiduciary duty. We maintain that prevailing interpretations of pension fund legal duties and common pension fund governance practices may be ill-suited for the complex investment instruments and the market-moving amount of assets now being managed by pension investors. We recommend changes in the interpretation of pension fund legal standards and identify priorities for improvements in pension fund governance to promote sustainability of wealth creation for both the pension and corporate sides of this symbiotic relationship.
The full paper appears in the Spring 2009 issue of the Rotman International Journal of Pension Management, published jointly by the Rotman International Centre for Pension Management and University of Toronto Press and is available for download here.